Be Prepared: Successful Sourcing Requires Pre-Contract Planning

Successful sourcing relationships are based on careful and detailed preparation before the contract is signed. Both parties need a clear understanding of the type of relationship desired. Sourcing contracts can consist of anything from a brief document with a price list attached, to hundreds of pages of legal documentation, terms, schedules, and flow charts.

While important, written documentation should be preceded by a thorough understanding of the type of relationship the client wishes to achieve and maintain over the life of the contract. The amount of time and effort required to structure a deal depends on the type of relationship being built. Key considerations include the following:

• Pricing: is the client willing to pay a premium for specialized expertise and business knowledge, or is low cost the primary objective?
• Vendor involvement: does the client expect a high or low degree of input and advice from the outsourcer?
• Length of relationship: does the client seek a long-term relationship, or are frequent vendor changes to be expected?
• Number of qualified vendors: are the services sought by the client highly specialized or widely available?

Based on combinations of these various factors, four different types of outsourcing relationships are feasible.

Value-Added Partnership

In one scenario, clients seek a high level of vendor involvement over the long term, and are willing to pay a premium. Few vendors are qualified to provide this type of service. This type of relationship is the true value-added strategic partnership. The client expects significant ongoing input from the vendor to identify opportunities for performance improvement. This may come in the form of access to the vendor’s technology, experience, or thought leadership. The vendor puts world-class technicians and relationship managers on the client-facing team, for which the client is willing to pay premium rates and negotiate a long-term contract.

Clients in a value-added relationship tend to be large multi-nationals operating in complex, fast-changing markets. Vendors capable of providing this level of service tend to be large themselves, with global operations, highly competent and experienced practitioners, and deep technological resources. The value-added relationship will often undergo significant change over the life of the contract, requiring a higher degree of flexibility in its construction and undertaking.

Critical Services

Another type of relationship involves a high level of vendor involvement, at premium prices, over a long period of time. The difference is that markets are served by numerous vendors of approximately equal capability.

Audit and tax firms, many outside legal advisors, and global recruiters fall into this category. The client seeks specialized, on-going advice, but is willing to substitute vendors to get comparable service at a lower cost. That said, longer-term contracts are desirable, as the vendor gains knowledge of the client – thus minimizing the learning curve of each incremental engagement.

Specialist Providers

Highly specialized service providers fill a specific niche that are not strategically critical to business operations. However, clients recognizes that only a few vendors perform these functions well – and are thus willing to pay a premium for them. Global payroll agencies and international travel firms are examples of such providers.

True Commodities

Finally, in true “commodity” relationships, clients outsource non-strategic services to one of many competent providers on a short-term, price-oriented basis. Long-term contracts are not desirable as a new player might enter the marketplace at any time, offering significant rate discounts as they build their business. The client does not seek significant input on how the job will be done; they just want it done, on time and to specifications clearly delineated in the contract.

Switching Objectives

So long as both client and vendor understand where their objectives and capabilities reside, the relationship will likely succeed. Difficulties arise when either party is unsure of, or changes, their position or stated objectives. Such shifts naturally lead to organizational and contractual tensions – sometimes ending in claims of contractual default.

Consider, for example, the client who emphasizes access to world-class capabilities in interviews with potential vendors, but who then negotiates solely on price. In essence, the client is asking for “added value” – but wants it a discount. Similarly, vendors who represent themselves as providers of world-class capabilities, but who then staff an engagement with junior or inexperienced practitioners to save costs, are just asking to be treated as commodity providers.

Clients who over-spec contracts are frequently frustrated by the lack of flexibility demonstrated by their vendors, while those same vendors are frustrated that they can’t demonstrate their creative capabilities to the client under the constraints imposed by the contract.

Occasionally, clients declare functions to be commodity-type services that really aren’t. A number of insurance and financial services firms learned this lesson the hard way, after customers voiced dissatisfaction with service levels provided by outsourced contact centers. As a general rule, direct customer contact in service or retail businesses is best considered to be a strategic function and not to be outsourced to commodity-type vendors.

Freeing resources for other, more strategic purposes might seem like a viable goal, but only if the outsourced operations don’t require significant two-way communication between client and vendor, or an in-depth understanding of the business that the vendor can gain only over time. A number of high-profile sourcing contracts have unraveled after outsourcers, particularly offshore outsourcers, failed to demonstrate adequate knowledge of the client’s business and customer needs.

Picking and Choosing

For clients who take the time and effort to truly understand the costs and strategic implications of their non-core operations, “selective” sourcing is often the best approach. In other words, a client that needs access to world-class capabilities for some operations outsources those operations to a world-class provider under a long-term, relatively flexible contract, and then listens to that provider’s advice. For this level of service, the client should expect to pay more than “best market price” and in return regularly receive value-adding input.

This same client can then outsource operations not requiring world-class capabilities to a commodity provider under a tightly-constructed, cost-focused contract which includes provisions for termination should the provider fail to meet expectations, or should a lower-cost provider come along. Under the best-case scenario, the client will optimize the cost and performance of these operations before outsourcing them to the commodity provider.

A well-managed approach to selective sourcing offers the client the potential for the best of both worlds: strategic help and access to world-class capabilities to add value, and low-cost provision of non-core services to maximize efficiency. As a side benefit, the client can free resources for other purposes, hopefully purposes that improve the company’s focus.

John Kopeck is president of Compass North America, based in Oak Brook, Ill. He is developing a forthcoming white paper on the topic of managing outsourcing relationships over time.